Don’t fall for the myths

Myths, misconceptions and misguided opinions swirl around the financial markets and often small investors fall prey to them.

I’m reminded of this every time I hear someone liken the stock market to betting in Vegas. The truth is that it’s not like that at all. When I own a stock I own a small fraction of a company and usually earn a dividend to boot.

When I play casino craps, I don’t own squat and will more often than not lose my chips. That is not to say buying stocks is not without risks, but to compare that to trying to hit a point in craps, a number in roulette or 21 in blackjack is nonsense.

I mention this because I read an excellent article in Financial Analysis Journal, written by Clifford S. Asness, in which he outlines several harebrained notions held by investors and air-headed phrases used by the Wall Street cognoscenti. Asness, who holds a doctorate in finance from the University of Chicago, is a respected money manager whose market insights are spot-on.

The article was headlined “My Top 10 Peeves,” and I basically share all of his peeves. Space constraints allow me to highlight just three of them, but for those who have time I would recommend the full article. His peeves are what he calls “commonly held and often repeated beliefs, [that] are wrong or misleading and they hurt investors.”

Let’s begin with his pet peeve regarding who was to blame for the financial crisis of 2007-2009. I start here because it’s important to know who the culprits were so we can perhaps avoid another financial calamity.

Sadly, much of the commentary in the financial press about this period is colored by extreme political bias. Those on the political left blame the big Wall Street banks, while those on the right blame big government.

The reality is — and it’s common sense — there was not just one culprit for the near collapse of our global financial system but many culprits. We had a massive credit bubble, a housing bubble, and worst all, a stupidity bubble. On that latter point I’m referring to average folks — bus drivers, teachers and fry cooks — who mistakenly believed they could afford million-dollar houses.

“You can’t get a good bubble off the ground without government, the financial industry, the real estate industry, the entire mortgage finance industry, rating agencies and regular individuals,” Asness writes.

Those are your culprits — all of them — and dare I say they populate the right and left ends of the political scale.

The second pet peeve that struck a chord with me involved bond investing. As most readers probably are aware, as interest rates rise, bond prices fall. And by the way, interest rates have been rising.

The conventional wisdom for those who want to own bonds is to buy individual bonds rather than bond mutual funds. The supposed logic of that goes something like this: It is smarter to own individual bonds rather than a bond mutual fund because bond funds never mature and fall in value as rates rise but individual bonds mature and investors can then get all of their money back.

This doesn’t make a lot of sense because as Asness writes: “Bond funds are just portfolios of [individual] bonds marked to market every day. How can the funds be worse than the sum of what they own?”

If that thought seems a little opaque to you, think of it another way. Let’s say that as your individual bond nears maturity, inflation spikes, interest rates rise and you are feeling all smug that you will get your money back. The problem is that in this rising interest rate environment, those dollars are worth less.

A third peeve of his — and one that makes me want to gnaw on the furniture — isn’t particularly harmful in that it just involves an empty phrase that’s become fashionable. Turn on CNBC on almost any day and you will probably hear a money manager say: “This is a stock picker’s market.”

Translation: The entire market isn’t rising at once, so give me your money and I will pick a winning stock from the losers. To that cockeyed logic, Asness says: “I don’t understand why active managers would suddenly get better at stock picking at those times.”

Money managers who use this phrase are basically saying they have to work a little harder now that the market isn’t doing the heavy lifting for them.

So when investment advisers drop that phrase on you, don’t believe they suddenly possess some magical ability to pick stocks. Just thank them for doing their job.

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